This article is part of Morningstar's Guide to Retirement Saving. All this week we are arming you with the tools you need to boost your pension pot and secure the best possible income in retirement.
Looking for income in retirement? Now that cash deposit rates are barely managing to beat inflation and bond rates are similarly poor if you’re not willing to re-enter the jobs market you may have to consider equities.
Below we highlight three of the highest yielding UK stocks on the market – and give the Morningstar equity analyst view on the company. Take note; not all high yielding stocks are attractive bets.
Morrisons (MRW)
Yield: 6.52%
WM Morrison is the fourth-largest grocer in the United Kingdom, but in contrast to its larger peers, it operates a vertically integrated supply chain with more than 15 manufacturing facilities and more than 10 distribution centres. These capital-intensive manufacturing operations pose a barrier for new entrants to overcome and give Morrison greater control over product quality.
Morrisons attempts to differentiate itself and capture the retail and manufacturing margin by touting the quality of its fresh food offering. However, we do not assign the firm an economic moat because we don't think it possesses a sustainable cost advantage or enough brand equity to sustain material price premiums.
The resurgence of discounters Aldi and Lidl in the U.K. has left Morrisons scrambling to fight for market share. Morrisons has been disproportionately affected by increased competition and evolving customer shopping habits; the firm’s customer base has more demographic overlap with those of the discounters.
Centrica (CNA)
Yield: 6.55%
We suspect the recent sharp decline in energy prices has resulted in Centrica rethinking its strategy to hedge its retail natural gas sales with its own assets. Its British Gas subsidiary is the largest natural gas retailer in the U.K., with more than a 35% market share. Centrica has also increased its U.S. presence. In 2013, its Direct Energy unit acquired Hess' energy marketing business for $1.2 billion, making the company the largest commercial and industrial natural gas supplier in the U.S.
Centrica's strategy is to hedge approximately 50% of its natural gas sales with its own assets. However, owing to the declining production in the aging Morecambe gas fields in the North Sea, Centrica has acquired several gas properties in Norway and North America and increased its exploration to maintain this hedge level.
We believe the most significant risk for our fair value estimate is Centrica's ability to execute its hedging strategy. This strategy requires Centrica to replace the production capacity of the declining Morecambe gas field. Management is attempting to replace this capacity by acquiring new gas fields, further developing its existing gas fields, and exploring for new gas. There is risk associated with all of these, especially exploration.
Royal Dutch Shell (RDSB)
Yield: 5.37%
Shell faces what amounts to an almost existential crisis: Even when oil prices were $100 its portfolio was strewn with problems. Huge bets on shale destroyed huge amounts of capital, cost overruns on key projects (the Motiva refinery, for example), and a chronically poor-performing downstream all combined to leave the company with very weak returns on capital. Even though significant restructuring actions have begun under new CEO Ben van Beurden, the recent collapse in oil prices adds considerable pressure that we think the company will struggle mightily to overcome.
Thus far, van Beurden has done all he can, and oil companies surely will be able to cut costs significantly from here to better align themselves with the new oil price environment. But investors should not expect miracles; Shell isn't Exxon or Chevron, and never will be. Improvements are indeed likely, but the firm is far more likely to remain a laggard than become a leader among the oil majors for the rest of this decade.
